On Our Radar

On Our Radar

Wary Investors Seeking New Retirement Funding Options

Many Americans saw their hard-earned retirement savings virtually disappear during the 2008 financial meltdown—along with their confidence in being able to afford a comfortable retirement.

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After all, with the country’s 90-year-old and older population nearly tripling over the past 30 years to 1.9 million 2010, and expected to more than quadruple over the next 40 years, people have good reason to be worried about not having enough money to fund their golden years.

The U.S. Census Bureau recently found that the annual median personal income for people ages 90 and older was $14,760 between 2006–2008 (in 2008 inflation-adjusted dollars); $20,133 for men, and $13,580 for women. Meanwhile, 92.3% of the income received by those 90 and older came from some sort of Social Security income.

“There’s a growing concern people aren’t going to have money to live comfortably or even pay their basic expenses,” saysTom Foster, vice president for The Hartford's retirement plans. He adds that people are becoming more concerned about funding life after work, noting a 2010 Hartford study that showed that 79% of respondents were concerned about having enough money to live comfortably into retirement, compared to 73.2% in 2006.

The government and private industry has been encouraging the creation and use of tools such as 401(k) annuities and pension-like funds that provide guaranteed lifetime income, despite market volatility.

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A March report issued by the Government Accounting Office found that most retirees rely primarily on Social Security and pass up opportunities for additional lifetime income. It also found that about 3.4 million people aged 65 or older in 2009 had incomes below the poverty level. The report also found aging workers need to focus not just on accumulating assets for retirement, but also on how to manage those assets once they leave the workforce.

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As traditional pension plans and defined benefit plans fade away, a growing number of companies are enhancing employees’ defined contribution plans by offering deferred annuities as a way to keep money flowing into workers’ golden years. Called guaranteed or retirement income solutions, many of these tools are add-ons to traditional 401(k) plans. Insurance companies like Prudential, John Hancock, Great-West and The Hartford offer annuity-like plans that offer guaranteed minimum monthly payments in retirement.

“The transfer of the investment risk that occurred when we moved from defined benefit pension plans to defined contribution plans, that transferred the investment risk to the employee,”says Michael Preisz, founder of Preisz Associates in Oregon and advisor at the Institutional Retirement Income Council (IRIC). Then 2008 came and went—but investors are still leery of investment tools. “Now the financial services industry is coming back and saying ‘look, we need to get some semblance of the old defined benefit plans back to give people some security,’” he says.

For small business owners, the various guaranteed lifetime income plans allow themto offer employees the option to create a pension-like account without the administrative headaches or costs associated with a pension. They also allow the employer to transfer the risk to the insurance company.

How it Works

Once you decide to enroll in one of these plans, you move your money from a mutual fund into another mutual fund with a rider attached. This establishes a “benefit (or “income”) base” number in your account on top of the market value of your money; the benefit base is initially set at the market value of your assets once you activate your account, and it can never drop.

As you make regular contributions, your benefit base goes up while your market value may fluctuate. Once a year, providers give you a “step-up” - they compare your benefit base to market value and move your benefit base up to market value. Many promise to pay 5% of your income base at retirement per year in your retirement, a number based on the highest benefit base you had with them.

“It actually gives you a minimum predictable guaranteed retirement income ... that makes me feel pretty good about these swings in the market. This is absolutely the antidote to market volatility,” Preisz says. “It really is investment insurance.”

The Hartford, for example offers a solution that says for every one share, you essentially can buy $10 of guaranteed income for life. Variables to the cost of each share include age, life expectancy and interest rates. There are no ongoing fees, and all fees are calculated into the price of each share. The product is a fixed annuity so there is no volatility. Although many employers, particularly small business owners, worry about the fiduciary responsibility of such plans, The Hartford allows a third party to act as co-fiduciary to decrease the burden, and allows participants to to take their money with them should they change jobs and providers. "It's portable, it's liquid, it's very simple," Foster says.

Although many are singing the praises of such lifetime income plans, not everyone is convinced.

Robyn Credico, a senior consultant at Towers Watson, which specializes in employee benefits, is skeptical such programs can become too widespread until the government can convince employers they won’t be held liable by workers if the financial services firm that offered the plan fails - another recurring nightmare from 2008.

“We all know it’s hard enough to manage a fund you can look at it and analyze it,” Credico says. “To predict an insurance company’s going to be around for that long is going to be a challenge. Certainly in today’s economy with AIG and a couple of others that took top money, that risk increased.”

Although Credico agrees that guaranteed lifetime income is needed he said the execution right now is very challenging.

The current plans can cause more record-keeping headaches since employers need to be in regular contact with the insurance company, which can hit small businesses with few resources. Plus, it’s not always easy to see the “devil in the details” with some of the plans, she adds.

“It’s really hard to understand these products. So, if most people are left to their own devices, they actually wouldn’t want to buy it.”

But groups like the IRIC are working with providers to try to work out kinks in portability, liquidity and other issues.

“This is a challenge the industry has to take upon itself,” Foster says. “I think you’re seeing more and more interest and you’re going to see more and more income streams.”